 |
Target-Date Funds May Miss the Mark
The much-ballyhooed target-retirement funds may not be a good fit for your portfolio.
October 2006
Target-date funds are supposed to make saving for retirement a straight shot. You pick the year you expect to leave work and when that time finally arrives, your investment program has hit a bull's-eye. But if you have been saving all along, throwing a target fund into your portfolio could send your existing mix off course.
Target funds, also known as life-cycle funds, essentially ask investors to make one-and only one-decision. The pitch: Just pick the year in which you expect to retire and let the fund sponsor do all the rest. Target funds, which invest in a package of other funds run by the same fund company, continually adjust the mix of stocks, bonds and cash. As you get closer to the target date, the mix becomes more conservative. The fund's manager does this by reducing the allotment to stock funds and increasing it to bond and money-market funds.
Take Fidelity's offerings, which are typical of the breed. Someone retiring in about 45 years might select Fidelity Freedom 2050. The 2050 fund places about 90% of assets in other Fidelity stock funds and the rest in high-yielding bond funds. If you're only nine years away from retiring, look at Freedom 2015, which holds about 60% of assets in stock funds, 6% in junk bond funds, 31% in investment-grade bond funds and the rest in money-market funds.
Throwing a Wrench in Your Plan
Life-cycle sponsors address almost all of an investor's concerns. Their funds provide instant diversification by allocating money among the major asset classes. And they continually rebalance that asset allocation. What could be easier?
Unfortunately, every investment has its shortcomings, and the life-cycle concept is no exception. The big problem is that target-date retirement funds are meant to be an investor's only holding. For a young person who has just started to contribute to a 401(k), a life-cycle fund makes sense. Pick the fund closest to the year of anticipated retirement and put your investments on cruise control.
But if you already own a portfolio of mutual funds and perhaps other securities, the question is: Does a target fund make sense? Probably not, unless you're willing to sell all of your investments, with all the tax consequences that such an action may engender, and redeploy the proceeds in a target fund.
The alternative to not remaking your existing portfolio is to undermine the purpose of the target fund. Suppose, to take an exaggerated example, you throw $1 million into a target fund that has three-fourths of its assets in stocks and one-fourth in bonds. But say you have another $1 million socked away in municipal bonds. Presumably, your goal in investing in the target fund is to acquire a portfolio that's 75% stocks and 25% bonds. But if you keep the munis, you end up with a portfolio that's 62.5% in bonds and only 37.5% in stocks.
Another problem is that these funds are cookie-cutter products. They're designed for the masses and do not allow for individual preferences. For example, if you're 55 or so with nine or ten years until retirement, you may find that the stock allocation of 60% in Fidelity's Freedom 2015 fund is too low. Because you can expect to withdraw from your portfolio for many years, you'll likely want your investments to carry more growth potential.
Like other target-fund sponsors, Fidelity's Freedom lineup also includes a more-conservative, income-oriented fund that is aimed at investors who are already retired. But, again, the mix may not match your own investing style.
In their own peculiar way, life-cycle funds also require discipline. Because they are designed to be a one-fund solution, you muck up the fund's carefully calibrated asset allocation if you invest elsewhere. But many investors can't help but buy the hot fund du jour or any intriguing fund they've read about.
The real problem with life-cycle funds may not lie in the funds themselves. No, the real problem may lie with investors. Most of us are too antsy to place all of our money in a single fund and hold it forever.
|
|
|
